Text: S&P on India's sovereign credit rating

A woman farmer carrying paddy crop is silhouetted against the setting sun on the outskirts of Agartala, capital of Tripura November 24, 2011.

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The following is text from a Standard and Poor's report titled "Asia-Pacific Sovereigns: A Bit Of Stability In The Sea Of Uncertainty?"

India (Republic of)

Unsolicited rating: BBB-/Negative/A-3; T&C BBB+ Last rating/outlook change: April 25, 2012. Outlook revised to negative from stable. Major rating factors Strengths - Good medium-term growth prospects - Deep capital markets - Moderately strong external liquidity Weaknesses: - Fiscal inflexibility due to high debt and large deficits - High inflation - Low-income economy Recent developments/major upcoming events Standard & Poor's has lowered its growth forecast on India for the fiscal year ending March 31, 2013, to 5.5%, from 7.0% previously, due to weak domestic and external demand. Following the 6.1% growth in the last quarter of calendar year 2011, first-quarter 2012 growth further decelerated to 5.3% year on year. Although there is still downside risk because of the uncertain external demand, the negative impact of the monsoon, and political paralysis, the declining growth may soon bottom out.

After P. Chidambaram became finance minister in August 2012, the government has announced reform measures, such as increasing domestic diesel price by about 12% and allowing up to 51% foreign ownership in multi-brand retail stores. The government also announced plans to increase the foreign ownership limit to 49% in insurance companies.

In addition, the cabinet approved foreign investors owning up to 26% (or 49%, depending on the successful enactment of the amended insurance laws) in pension-related businesses. After a long wait, the government seems to have reignited reform efforts, and that bodes well for the future development of the country.

With two state elections, including Gujarat, which will be held December 2012, the government has only a small window to implement reforms.

However, the political cost has become apparent, with one member of the coalition quitting. As a result, the coalition has become the minority in both the upper and lower houses of parliament. Although the ruling coalition expects support from friendly parties, the political condition tends to become more fluid ahead of the general election expected in 2014. The foreign ownership reforms for the insurance and pension business are likely to become more challenging as they need parliamentary approval.

On the fiscal front, we expect the central government will record a deficit of about 6.0% of GDP for the fiscal year ending March 2013. Weaker-than-expected tax receipts, owing to weaker economic growth, and higher-than-budgeted subsidies are the main reasons behind it. On the other hand, many state governments' fiscal conditions have been adversely affected by the state power companies' weak and worsening financial conditions.

In late September, the government announced plans to restructure debts owed by the State Electricity Boards. Part of their debt will be guaranteed by the state governments.

Inflation remains sticky in India. The raw consumer price index eased below 10% in both June and July. On the other hand, the wholesale price index (WPI) rose by 7.55% in August, a rebound from 6.87% in July, the lowest level since November 2009. However, the WPI is still above Reserve Bank of India's medium-term target of 4%-5%. And the trade deficit remains relatively large in recent months. We therefore expect the RBI to remain cautious in conducting its monetary policy in the coming months.

The current account deficit for this fiscal year ending March 2013 is likely to be 3.5%, below last year's 4.2% of GDP.

The current account deficits have been counterbalanced by the net inflow of FDI and portfolio investments so far.

However, if the current account deficit shows little improvements going forward, the country's external position could cease to be a supporting factor for the sovereign ratings.

Outlook

The negative outlook signals at least a one-in-three likelihood of a downgrade of the sovereign rating on India within the next 24 months.

A downgrade is likely if the country's economic growth prospects dim, its external position deteriorates, its political climate worsens, or fiscal reforms slow. On the other hand, we may revise the outlook back to stable if the government implements initiatives to reduce structural fiscal deficits, improve its investment climate, and increase growth prospects. Fiscal measures to lower deficits could include a more efficient use of fuel, fertilizer, and agricultural subsidies, or the implementation of a goods and service tax.

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